Asset pricing and financial markets
This course is aimed at students who wish to understand how financial markets work and how securities are priced.
- Present value calculations; discounting, compounding and the Net Present Value rule; quoted versus effective interest rates; annuities and perpetuities; Fisher separation.
- Bond valuation: valuing coupon, and zero coupon, bonds via present value methods; the term structure of interest rates and bond valuation; yield to maturity; interest rate risk and Macaulay duration; spot and forward interest rates; modelling the term structure of interest rates.
- Stock valuation: dividend discount models; the Gordon Growth model; earnings, payout ratios and stock prices; company valuation and the Present Value of Growth Opportunities.
- Portfolio Theory and the Capital Asset Pricing model: investor preferences; the mathematics of security portfolios; investor portfolio selection; market equilibrium and the CAPM; empirical evaluation of the CAPM and competing models.
- Efficient security markets: defining informational efficiency; why should markets be efficient?; problems with testing efficiency; evidence on the efficiency of stock markets; puzzles and anomalies.
- Derivative pricing: the definition of a derivative contract; how to price derivatives using absence of arbitrage; forwards and futures contracts; pricing forwards on stocks, currencies and commodities; option contracts; practical uses of options contracts; bounds on option premia; option pricing via binomial models and Black-Scholes.
If you complete the course successfully, you should be able to:
- Describe the important differences between stock, bond and derivative securities.
- Explain how to price assets using both present value and absence of arbitrage methods.
- Apply present value techniques to price stocks and bonds
- Employ mathematical tools to compute risk and return for portfolios of securities.
- Evaluate portfolio choice problems.
- Present, explain and apply the Capital Asset Pricing model for computing expected stock returns.
- Critically evaluate the evidence for informational efficiency of stock markets
- Price derivative securities using absence of arbitrage.
- Brealey, R, Myers, S. and F. Allen Principles of Corporate Finance. 11th edition. (McGraw Hill)